The Changing Role of Non-Profit Microfinance: An analysis of the changes in aspects of microfinance
outreach over the last decade.
Adam Krauland
December 2012
Senior thesis submitted in partial fulfillment
of the requirements for a
Bachelor of Science in Economics
at the University of Puget Sound
Introduction.
Defeating extreme poverty is one of the greatest global challenges today. The World Bank
defines extreme poverty as people living with an income at or below $1.25(US) a day. Conservative
estimates place the number of people living in extreme poverty at around 1.3 billion. If the income
threshold is increased to $2.00(US) a day, the number of people living in poverty approaches 2.5 billion
or 35.7% of the world’s population. Combating poverty is of vital importance and in the last century
microfinance has risen as the primary tool for poverty reduction. Aliya Khawari (2004) defines
microfinance as an institution that provides one or many different banking services, such as loans,
insurance, and deposits to people who do not have access to formal banking institutions. People who take
advantage of these services are generally members of poor and low income households or enterprises.
These people are able to use these loans to create opportunities previously unavailable to them and
potentially increase their status in life. These loans can be used to invest in businesses, to buy technology
to better communicate, or simply allow a person to buy clothes to be able to be able to work a job. In this
way, the services of microfinance translate directly into increased social welfare for its clients that would
otherwise be unattainable.
The microfinance sector began in the 1970’s and initially was comprised of non-profit
organizations (Khawari 2004). However, in the last forty years microfinance institutions (MFI’s) have
undergone many changes, the most significant occurring in the last decade. In 1992, Prodem, a non-profit
microfinance organization in Bolivia joined with local banks to become Banco Sol, the first commercial
microfinance enterprise in the world (Schriener 2002). After this venture proved successful, for-profit
enterprises became increasingly common in microfinance, innovating and changing the industry
significantly. The commercialization of microfinance, spectacular growth in technology, and growing
political awareness of microfinance as an effective poverty reduction tool has changed the way the world
views microfinance from simply another charity delivery mechanism to a viable commercial opportunity
with profit potential.
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While the original goal of microfinance was to help alleviate poverty and increase social welfare,
much has changed in the industry over the last decade, making it increasingly pertinent to analyze the
shifts in microfinance and their impact on the impoverished. As a sector of the financial industry, there is
much analysis of microfinance and the trends that are occurring within the sector in order to study the
effects of microfinance on the impoverished and evaluate microfinance’s efficiency and outcome for its
clients. To date, there is little research looking into the effect of the changes in microfinance on the social
welfare of the clients that are consuming its service. It is important to know how the changes in
microfinance are effecting the impoverished, whether it is beneficial, and what these changes mean for
the role of non-profits in a sector that is increasingly being penetrated by for-profit microfinance ventures.
In this paper I will use a framework for evaluating the effectiveness of outreach by microfinance
organizations in order to analyze how the impact of drivers of change such as increased competition,
technological progress, entry of for-profit firms and a change in political climate have affected the social
welfare delivered by non-profit microfinance. Due to these forces there has been a marked mission drift in
the delivery of microfinance which has resulted in much less emphasis on lending to the poorest persons.
In addition these forces have caused a change in the role of non-profit microfinance from that of the
innovator and entrepreneur of microfinance to being one part of a greater sector delivering finance
services to the impoverished.
Review of Literature.
Rhyne and Otero (2006) have determined that the changes in microfinance can be distilled to four
different forces; competition, commercial entry, technology, and an enabling political environment. They
found that increases in competition between lenders in Latin American countries resulted in increased
productivity, reduced operational cost and a lower interest rate to the borrowers. Figure 1 shows the
interest rates on microfinance loans in Bolivia from 1998 to 2005.
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Figure 1 (Rhyne and Otero, 2006, pg. 15)
In the last 20 years commercial entry into microfinance has considerably increased after the first
few commercial microfinance organizations’ “demonstrated profitability, business models that can be
copied, and competencies for working with low income populations” (Rhyne and Otero, 2006). The entry
of the commercial sector into microfinance has resulted in many more firms and thus increased
competition. The commercial sector has also introduced much greater efficiencies into microfinance
through the drive for greater profit.
Technology has been the greatest driver of change over the last two decades. With the
popularization and proliferation of internet information, sharing and processing has never been easier.
Access to microfinance services has become much easier as physical transactions are no longer needed.
MFIs have classically relied on a great deal of personal interaction which has high associated costs,
however, technology is allowing this to change, creating a new more efficient and cost effective
relationship between borrower and lending institution. Rhyne and Otero also point out that microfinance
is beginning to use technology not just to manage and enhance information, but on the front end with
clients, utilizing ATM’s, smart credit cards, satellite communication, cell phones, etc. Caudill Gropper
and Hartarska (2009) present a mixture model that suggests that the overall costs of microfinance
organizations are decreasing and relate this to, among other factors, technological progress.
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Throughout the history of microfinance organizations, governments have for the most part been
adopting policies that lead to more liberal financial markets. Rhyne and Otero found that microfinance
does well in “settings where the government did not follow directed credit policies, allowed interest rates
to be market-determined, kept credit allocation separate from politics, and was not itself involved in direct
lending” (pg. 19). In a case study focused on regulatory frameworks, Gallardo (2002) found that in Ghana
and the Philippines, a tiered regulatory framework that clearly identifies pathways for lending institutions
to become legitimate can lead to greater realization of outreach potential for non-profit microfinance
organizations.
Schriener asserts that the main objective of microfinance is to improve the welfare of the poor. In
addressing whether poverty-focused MFIs or sustainability-focused MFIs improve social welfare the
most, Schriener created a framework for outreach to evaluate the impacts of microfinance on society.
Schriener’s framework consists of six different aspects in which a microfinance organization enhances
social welfare: worth, cost, depth, breadth, length, and scope. This framework, while being highly
conceptual, allows one to measure, however rudimentarily, the social benefit of a MFI.
Schriener defines the worth of outreach to clients as the client’s willingness to pay for the
lender’s services. These costs depend on the financial contract as well as the tastes, constraints, and
opportunities of the client. The cost to the client of welfare is defined as the sum of the price costs and the
transaction costs, where price costs are direct cash payments for interest and fees while transaction costs
are measured by non-cash opportunity costs as well as indirect cash expenses. The depth of outreach is
the value that society attaches to the net gain of a client. Assuming, for example, that society would rather
give a gain to a poverty stricken individual rather than a wealthy person, one can infer that the worse off
someone is, the greater the depth that is attributed to lending to them. Some examples of this would be
lending to females as opposed to males, in rural locations versus urban ones, to people with less education
rather than more, to people with less access to public resources rather than more. Breadth is the number of
clients reached. As breadth increases more people in society are receiving financial services, and
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assuming they wouldn’t engage in the services unless there was some benefit to it, one can say that the
greater the breadth, the greater the outreach. Length of outreach is defined as the time frame of supply of
microfinance. Finally, scope of outreach is defined as the number of types of financial contracts supplied.
The greater the scope, the more services one can access at a single institution, allowing for lower
transaction costs for the various social welfare services.
Analysis.
The last ten years has seen a great deal of change on a global scale. The internet has come into
prominence, as well as the mobile industry has boomed, resulting in more than 2 billion mobile phones
currently in use (Donner 2005). For the first time recently the microfinance industry is comprised of both
non-profit and for-profit organizations. The critical question that arises is what effects do these changes
have on non-profit microfinance, and more specifically, on the different aspects of its outreach?
The amount of services provided by a non-profit firm differ in a fundamental way from a forprofit firm. As shown in Figure 2, due to the non-distribution constraint, a welfare maximizing non-profit
will not serve at the traditional profit maximizing point where a for profit firm will choose to operate.
Instead the non-profit firm will produce where marginal revenue is equal to average cost (Q*). This
maximizes the services provided by a non-profit organization, and therefore maximizes the welfare the
MFI delivers to its clients, all else held equal. The important result from this is that any increases in
technology or lower costs for a non-profit firm should be turned completely into greater output, or greater
welfare delivered to the organization’s clients (Q’). As average cost decreases, quantity produced will
increase. This relationship indicates that the amount of social welfare a microfinance firm delivers is
directly affected by any changes in non-profit microfinance’s costs.
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Figure 2
Using Schriener’s framework, one can analyze how outreach is changing in microfinance due to
Rhyne and Otero’s four main components of change. Conclusions may then be drawn as to why
microfinance outreach has been changing as it has, and what the implications of this change are for the
industry. The aspects analyzed will be Cost, Depth, Breadth, Scope and Length, excluding the worth to
clients. The value a client derives from a service is highly subjective and any attempt to measure this
value would surely be subjective and conjectural and thus will be excluded from this analysis.
The data provided for the analysis comes from Mix Market (accessed at www.Mixmarket.org)
which provides a free dataset on both for-profit and non-profit microfinance organizations. The data
includes over 12,000 observations from 1997 to 2011, 7350 observations from non-profit microfinance
firms and 4733 from for-profit firms. It comprises firms from all six continents and every major region in
the world. The data provided by Mix Market is not self-reported; rather it is taken from audits, financial
statements, and other documents. It has multiple year information on over 2000 different microfinance
organizations from all over the globe. This, paired with the nature of the information retrieval, makes it a
reliable source of information for the various aspects of a microfinance firms finances.
Governmental effect on the aspects of outreach
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The effects of governmental policy, while surely important for each of the aspects of outreach,
are extremely varied and specific from region to region making it difficult to determine what the overall
effects of individual countries are on the entirety of microfinance outreach. While governments have for
the most part accepted and tried to incorporate microfinance into their policies, the effects of
governmental intervention on certain aspects of outreach are too specific for any general claim to be
made. Some governmental policies are restrictive, putting caps on the rates MFI’s can charge as well as
what types of services they may provide, severely limiting their abilities. In contrast, other governmental
policies have done the opposite, creating protectionist policies and helpful frameworks which give
microfinance an environment in which it can thrive, experiment, and grow.
Breadth of outreach
Breadth of outreach is simply the number of clients using the micro lender’s services. The more
people able to engage in micro financing, the greater the social benefit and outreach an organization is
able to contribute to society.
As technology makes back-end computations faster and cheaper, organizations are able to
manage their clients more efficiently. Information sharing between firms allows the MFIs to have better
information on clients, resulting in better decision making regarding borrowers and lending terms.
Improvements in communications allows for better contact with clients, which can create a greater sense
of responsibility for the client to repay their loan. As informational efficiencies increase one would expect
the rate of arrears to decrease. Firms can better align their assets, and lend to more clients, increasing
breadth. In addition, the increased availability of communications allows the MFIs to reach a greater
client base as travel becomes less of a necessity.
Competition forces MFIs to expand their client base. More competition in a market incentivizes
firms to lower costs in order to be competitive. Lower costs make the firm’s services attractive to more
clients. Similarly, the pressure of competition on cost will allow the firm to accept more clients. The
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substantial increase in breadth is shown in Figure 3 which depicts the increase in number of clients for the
largest 20 MFI firms from 1996 to 2007. This figure shows the effect of competition increase on the
breadth of outreach in the MFIs.
Figure 3 (Mix Market, 2012)
The recent surge in commercial microfinance has increased breadth of outreach greatly. Using
new and creative lending models to cut costs and increase profitability per loan, for-profit organizations
have created a profit focused approach to microfinance which puts emphasis on increasing number of
clients. These models are being copied by non-profit firms who hope to also become financially
sustainable.
The breadth of outreach is the simplest aspect of outreach to measure as it is just the number of
people receiving microfinance services. Figure 4 shows the increase in total clients receiving MFI
services over the last decade. This can be attributed to lower costs and prices in microfinance. Similarly,
this increase can be attributed to a greater desire to offer these services as the model of microfinance
becomes more sustainable. The two declines on the graph are seen in 2001 as well as around 2008. These
correspond to the two financial market crashes, one being the tech bubble and the other the more recent
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housing bubble. This allows insight into how important financial expectations are in the delivery of
microfinance services to non-profit MFIs. These numbers show that the breadth of outreach is indeed
increasing, as microfinance services are being delivered to greater and greater numbers of people around
the globe.
Figure 4. (Mix Market 2012)
Cost to Clients of Outreach
The cost to clients of outreach is the amount of money that is necessary for a client to access and
participate in microfinance. This manifests itself in such things as payments for fees and interest on loans.
The costs of outreach to clients also includes opportunity costs. An example of this is time spent applying
for and utilizing the microfinance’s services as well as the cost of gas and paper and any other expense
incurred to be able to use the service.
The increase in technology has had a pronounced effect on the cost to clients of outreach. Donner
reports that in 2005 over 80% of the world lived within range of a cell phone network (pg. 2). Small
businesses and social entrepreneurs have been making increasing use of this technology. Mobile phones
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are a low cost way to communicate with a borrower to share information that would otherwise require a
trip to the offices of the microfinance institution. In addition to cell phones, technologies such as ATM’s,
the internet, and credit cards, allow for the basic functions of an MFI to be used remotely. These
technologies can be used to access one’s account and even allows for repayment, minimizing both time
and travel costs to the client
Competition decreases the cost of outreach. As more firms enter the market, clients have more
choice of where to borrow and so they can choose a firm that can provide the lending services for the
lowest cost. Knowing this, firms will do their best to lower the costs to their clients, so as to attract the
optimal amount. Secondly, having more than one firm in the market will inspire creativity for firms to
come up with more cost-effective ways of operating in order to lower their operating costs, prices, and
increase output.
Commercial entry in microfinance has caused lower costs. Using the profit motive to structure its
processes differently; commercial organizations have found many ways of reducing MFI’s costs. These
business models can and are being copied by the non-profit MFIs, and being used to reduce costs across
the board.
Directly measuring the cost to clients of outreach is difficult due to the methods of financial
record keeping. Focusing on monetary costs as proposed by Mersland and Strom (2008), one can look at
different aspects of the income yield of microfinance as it makes up the revenue ratio of monetary costs to
clients. Figure 5 shows the trend of the Average Operating Expense Ratio of non-profit and for-profit
organizations. The trend is downward signifying reduced operating expenses which allow the cost to
clients to decrease, increasing clients’ welfare. However, when looking at the firms Average Portfolio at
Risk in Figure 6 as well as the Average Write off Ratio in Figure 7, these diagrams show an increase in
risk and write-offs over the last decade. When looking at the Average Cost of Funds Ratio an increasing
trend is again observed (Figure 8). This leads to the conclusion that lower operating expenses are
allowing non-profits to increase their lending. When lending increases so does the amount of risk taken
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on by a firm. This is due to the fact that as a firm expands their number of clients they must relax their
risk threshold to include a greater population to lend to. This causes their overall risk to increase as a
result of lowered operating expenses and increased lending. The ability to lend to more clients indicates
an overall decrease in the cost to clients.
Figure 5. (Mix Market 2012)
Figure 6. (Mix Market 2012)
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Figure 7. (Mix Market 2012)
Figure 8. (Mix Market 2012)
Depth of outreach
The depth of outreach is the value that society places on the gain of a client. In the case of nonprofit microfinance, whose goal is to reduce poverty, value is increased by helping people who are worse
off in society. Basic proxies for this are income, education, area, ethnicity and sex. The less income and
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education a client possesses; the more depth of outreach. Similarly, if a client is female, a minority, or
living in a more rural area, depth is increased relatively. These demographics and thus depth of outreach,
equate to how well microfinance reaches those people in society with the greatest need. Therefore, by
definition, an increase in depth of outreach leads to an increase in overall outreach.
The technologies that facilitate changes in depth almost entirely revolve around the
communications revolution. This effect is two-sided. The proliferation of cell phones and the internet
allow more rural populations to communicate with and utilize the services of microfinance organizations
which are likely to be located in more populated centers. Similarly, this technology allows the reverse as
well. With better communication the MFI’s are better able to seek out the socially disadvantaged, whether
it be women, the poor, or those in rural communities. Better technology provides increased information.
MFIs can utilize technology to determine where their services are needed and provide them to those
markets. One potential negative consequence is that an increase in reliance on these technologies can
make borrowing prohibitively expensive for the poor who cannot afford mobile technology or internet
services.
As more institutions enter the microfinance market, the number of clients able to utilize the
services will increase. This is due to a firm’s physical ability to lend to more clients, but due to the effects
of competition, these firms will need to lower their costs and have more money to lend in order to attract
business. Firms will also expand their financial services in order to better meet the needs of a larger
number of people. These actions will cause organizations to seek out clients beyond their original scope.
This includes clients who are not located near the MFI, clients who could not originally afford the
services and clients who would not have been accepted previously for other socially undesirable traits,
such as being women or minorities.
The entry of commercial organizations has put more emphasis on financial sustainability in the
microfinance sector. With this focus on increased financial sustainability comes a de-emphasis on the
depth of lending. This is due to a general shift in opinion that lending to the less poor and thus lowering
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arrears rates, or overdue money, is more socially beneficial because the organization can be more
financially sustainable. Khawari reports that average income impact of borrowers near poverty line is
greater than those below the poverty line or in other words, borrowers near the poverty line get more
financial improvement from using MFI’s services. This focus has steered the sector away from the more
socially disenfranchised.
The depth of outreach is most easily ascertained by looking at two different values. The first is
the Percentage of Female Borrowers (Figure 9). While relatively high to begin with, non-profit
microfinance has not increased the percent of female borrowers by significant amounts over the past
decade. Given the already high percentage, this could be due to the fact that they are already reaching a
large amount of female borrowers and so are not concentrating any extra efforts to this cause. Another
proxy measure, though not as useful, is the Average Outstanding Loan per Client (Figure 10). The greater
the average outstanding loan, the less impoverished the client base as poorer people cannot afford to take
out larger loans. This value has also not changed much, yet increased slowly and steadily over the last
decade. The conclusion can only be that the depth of outreach is slightly decreasing. The recent emphasis
on loan sustainability versus lending to the lowest classes has resulted in non-profit firms decreasing their
total depth of outreach to their clients. This trend is more prevalent in for-profit microfinance, which has
seen a huge increase in Average Outstanding Loan per Client, showing the focus on greater revenue
versus greater social welfare for these organizations.
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Figure 9. (Mix Market 2012)
Figure 10. (Mix Market 2012)
Length of outreach:
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Length of outreach refers to the amount of time a specific microfinance firm is able to deliver its
services, or in other words, how long the firm is able to operate in a given location. This analysis will
focus on lenders leaving markets solely due to lack of funds to continue operations. If the organization
ceases to exist, so does its welfare enhancing benefits. When a client uses an organization more than once,
there is a reduction in transaction costs as some trust and information has already been established. The
longer an organization exists, the greater the outreach it is able to provide.
Technology’s role in determining length of outreach is less salient than other aspects. The length
of outreach of an MFI is mostly determined by how profitable the firm is, allowing it to continue its
operations. While technology helps by reaching clients and lowering arrear rates, it doesn’t do much to
directly contribute to the lengthening of the presence of an MFI, though it does allow it to be more
sustainable. The direct effect of technology on length is unclear at best, though it is more likely to
increase length than reduce it.
Competition’s effect on length is similarly unclear. As more firms enter a market, increases in
competition will cause the revenue per unit of loan or total revenue for each individual MFI to decrease.
This means that if a firm does not increase its efficiency enough to be able to reduce its loan rates to
remain competitive with other firms; it will be forced to leave the market.
The more firms entering the market, the more competition a MFI has in obtaining donations.
Donations can be vital for non-profits as their social focus generally makes them less financially
sustainable due to inefficiencies and arrear rates associated with lending to the most poor. The firms that
are able to stay in the market will thus be more sustainable.
Profit seeking firms have revolutionized microfinance with the realization that microfinance
services can be delivered to the poor profitably. Driven by big banks and investors, the focus of the
commercial sector to create revenue has produced a model where microfinance does not need to rely on
donations. While donations allow non-profits to operate longer, donations are not a very reliable source of
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income. As non-profits mimic the for-profit model of financial sustainability they too become less reliant
on donations. This allows them to deliver their services for a greater length of time.
The length of outreach is best determined by using the firm’s returns as a proxy. A non-profit
microfinance organization will stay around until its services are not needed or until they are unable to
fund their services. Since the number of impoverished is high we can assume length is only affected by
whether or not a non-profit MFI is able to continue operations. A reliable method of determining this is
by looking at the firm’s revenue in excess of costs. Since these organizations are subject to the nondistribution constraint, any revenue earned exceeding costs can go back into the business, and towards
maintaining their services. Figure 11 shows the Average Profit Margin made by non-profits over the last
decade. It is clear these values are increasing as non-profits put more emphasis on financial sustainability.
In the last year non-profits have averaged a positive profit margin, and thus the longevity of these
institutions has increased as they are not forced to look for donations or drop out of the market due to
losses. This permits much greater length of outreach.
Figure 11. (Mix Market 2012)
Scope of outreach:
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Scope of outreach is the number of types of financial services provided. There can be scope
between products, such as having savings accounts as well as loans, and scope within products, such as
loan contracts for many different amounts ($100 loan, $200 loan, etc.). The greater the scope an
organization offers, the more clients it can satisfy through greater specialization. Therefore, as scope of
outreach increases, the overall outreach and social benefit of the organization increases.
Technology has had a profound effect on the scope of outreach. The internet has allowed MFIs to
require less human capital in the production of their services, so offering an additional service does not
require the number of skilled workers it would have previously to carry out transactions for its services.
This allows microfinance firms to provide many different services to its clients at a low cost. Similarly,
new computing technologies allow MFIs to be much more flexible in their financial contracts, allowing
for a spectrum of loan values. Due to this flexibility MFIs are able to more easily customize their services
for each client.
Competition is probably the biggest driver of change when it comes to a firm’s scope. As more
firms enter a market, each firm will seek to differentiate itself from the others, offering more customized
and unique services to attract potential clients. Also, competition causes firms to reduce the cost of
offering each service, making it less costly and therefore more desirable for a firm to increase the range of
products they have available.
The innovations of the commercial market have shown that microfinance can do more than just
offer loans in order to help their clients. With the introduction of other financial services, market entry has
spurred growth in the scope of outreach among MFIs.
Data on the increases in scope of outreach is difficult to gather on a global scale, but anecdotally
the evidence does point to greater provision of unique financial services in microfinance organizations.
Figure 12 shows the diversification of financial services offered by the for-profit firm BancoSol from
1997 to 2006. All of microfinance, non- and for- profit, has much incentive to increase their product
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offerings as it will increase their customer base as well as providing plans that better suit customer needs,
thus decreasing the rate of arrears.
Figure 12. (Rhyne and Otero 2006)
Over the last decade microfinance has become much more prevalent and more effective due to
changes in technology, the increase in competition, and the entry of for-profit firms and their new
approach to lending. The culmination in these processes has impacted non-profit microfinance and has
altered the way it approaches the delivery of financial services to the poor. The next section will go into
more detail on what has changed and what it signifies for the non-profit microfinance industry.
Implications
The outreach of non-profit microfinance organizations has changed dramatically in the last
decade. The focus on greater depth and reduced costs to the client has been de-emphasized. In its place,
these organizations have instead put their efforts into increasing their longevity and have focused on
increasing clients and revenue. The result is a marked mission drift in the non-profit microfinance
industry.
Non-profit microfinance was created in order to bring financial opportunities to those without
access to formal lending solutions. This led to a goal that is best described as “increasing the welfare of
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the poor”, implicitly referring to the poorest. Yet in the last decade, while different forces have created an
industry that is much more efficient and effective, lending to female clients has remained stagnant (Figure
9), and the average size of loans has increased; an indicator that the non-profit MFIs are lending to clients
who are less impoverished (Figure 10). These facts point to either a stagnation or reduction in the depth
of outreach as delivered by non-profit MFIs. This trend is contrary to the original goal of microfinance to
help those who are financially the worst off.
This mission drift is due to a shift in the climate of opinion in microfinance surrounding the best
way to deliver its services. The new focus on sustainability has come out of a series of papers by Mosley,
Hulme, and others who have found that,” MFIs are likely to produce a higher income impact by focusing
their lending on clients just above the poverty line who would also invest in technology to improve the
efficiency of their activities helping them earn higher returns on their investments” (Khawari 2004).
While this mission drift has caused non-profit MFIs to stray from reaching the most
impoverished, there are a couple things worth noting. Firstly, the move towards self-sustainability and
lending to clients at or above poverty line has been proven to have a greater impact. This increase in
impact is due to the fact the less impoverished can borrower greater amounts, allowing them to use the
finances to fund more viable or profitable business ventures. The small amounts of money available to the
most impoverished are less likely to be used for capital purchase, and thus have less effect on the overall
incomes of the borrowers. The result is a larger welfare increase for the same amount of money lent per
loan. Even though mission drift has occurred, it has been in a direction that has increased societal
benefits. It is also important to understand that poverty is defined as peoples who make an average
income of $1.25(US) a day. Keeping this in mind, lending at or just above poverty level is still reaching
extremely poor people.
This shift towards greater sustainability is pushing non-profit microfinance organizations towards
operating in ways similar to for-profit microfinance organizations. In almost all aspects of outreach, nonprofits have converged with for-profits over the last decade. As for-profits focused their efforts and
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innovations on becoming profitable, non-profit microfinance copied these innovations and as a result
Figure 11 shows the gradual increase that both non-profit and for-profit microfinance sectors enjoyed in
their profit margins. Similar trends are found in the breadth of outreach (Figure 6) as well as in risk taken
on by the firms (Figures 6 and 7). Non-profits and for-profits are building off each other’s ideas creating a
sector that is more homogenous.
Despite the increasing homogeneity between the two sectors, there are two aspects where nonprofit and for-profit microfinance organizations are increasingly different. The Cost of Funds Ratio
(Figure 8) is increasing for both sectors, yet the rate at which it is increasing for for-profits is much
greater. The same trend is seen in the Average Outstanding Balance (Figure 10), which while increasing
steadily for non-profits, has begun to climb sharply in the last couple of years for for-profit MFIs. These
two trends highlight the defining differences between the non-profit and the for-profit microfinance sector
today.
The cost of funds ratio for a lending institution is the cost incurred by the institution to raise the
funds necessary to lend to borrowers. People who invest in microfinance do so because of the high
returns that are generated by the high risk of non-collateral lending to the impoverished. This leads to forprofits lending on average much greater sums and undertaking much more risk than non-profit MFIs
(Figures 6 and 7). Due to this for-profit microfinance organizations will have greater costs to clients of
outreach when compared to non-profit organizations.
The increasing popularity of microfinance has resulted in the number of firms investing in these
financial products increasing, leading to greater competition. In order to increase profits, for-profit
microfinance has not only increased its risk, but has also increased the average amount it lends to
borrowers (Figure 10). Larger loans mean greater interest payments and profits which draws more
investors to the for-profit firms. The effect of this, though, is to decrease the depth of outreach delivered
by for-profit microfinance. This is because the more impoverished cannot afford to borrow increasingly
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greater sums of money. Non-profit microfinance, however, has not experienced such a marked increase in
its Average Outstanding Balance.
The result is a microfinance sector comprised of two types of organizations, non-profit and forprofit. These organizations are becoming increasingly similar in outlook and mission, delivering
microfinance services to the poor, but in such a way that the organizations can make a profit and so be
sustainable. Both are creating new and innovative lending methods using recent technological advances to
reach and meet the needs of a broader range of clients. Whiles costs overall are greatly reduced, for-profit
firms are delivering larger loans at a slightly greater cost per dollar. This reflects their need to meet their
shareholders desires of greater profit through risky financial products. Non-profits, however, are loaning
smaller amounts to clients, at a slightly lower cost. Apart from these differences, these organizations are
offering comparable loans as well as outreach, creating an increasingly predictable and consistent
microfinance sector.
As non-profit and for-profit MFIs become more similar it becomes increasingly pertinent to ask
what the role non-profits play in the microfinance industry. Initially non-profits played the role of social
entrepreneur in the microfinance industry, innovating by developing and applying new technology
(Frumkin, 2002). They used their lower costs and donations to provide a service that was prohibitively
costly for commercial firms. Due to increases in innovations, technology, and efficiency this is no longer
the case. The microfinance sector now more closely approximates other mixed sectors such as hospitals,
nursing homes, and daycares in that roughly the same services are available from both for-profit and nonprofit providers. This is because changes led to a great enough increase in profit and decrease in costs that
entry began to take place .While one might believe the for-profit’s ability to provide a comparable service
more efficiently and competitively would put pressure on non-profits forcing them out of the industry,
this has not been the case; for hospitals or microfinance organizations. Rather the ratio of non-profit to
for-profit microfinance organizations has stayed largely the same over the last ten years (Figure 13).
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The theory that non-profits step in to alleviate contract failure, as proposed by Hansmann (1980),
provides a framework for describing the current relationship between for-profit and non-profit
microfinance. Being non-profit allows microfinance organizations to enjoy greater trust from their
borrowers, differentiating themselves from the more competitive for-profit organizations. In this way the
less efficient non-profits are able to retain their position in the microfinance industry because some
borrowers will prefer to use the services of a firm that is not motivated by profits while other clients may
prefer the greater infrastructure and efficiencies that come with profit focused microfinance.
Figure 13. (Mix Market 2012)
Conclusion.
Over the last decade the landscape of microfinance has shifted dramatically. Due to
changes in technology, competition, policy, as well as the entry of for-profit firms, microfinance is much
more efficient, profitable, and effective. The number of organizations providing microfinance services has
increased exceptionally, as well as the number of people receiving these services. Using Schriener’s
framework for analysis of microfinance outreach it becomes clear that social welfare generated by
microfinance today dwarfs that of a decade ago. The way in which microfinance improved this welfare
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led to a change in the ways it delivers its outreach. Due to competitive forces and mission drift of nonprofits towards focusing on self-sustainability and thus increased revenue, microfinance organizations are
lending to less impoverished people as well as slightly increasing the cost to the clients. This has allowed
non-profit MFIs to increase the number of people it lends to as well as increasing the length of time the
firms operate, allowing for repeated lending in the community. These changes are making non-profits
more similar to for-profit MFIs, reflecting a shift in the role of non-profit microfinance from that of the
entrepreneur proving the feasibility of microfinance to one part of the larger and more demanded
microfinance sector of today. There is very little literature on the negative impacts of the recent changes
in microfinance, and that is reflected in the arguments presented in this paper, which are surely skewed in
a positive direction. Further research should be directed towards the possible negative effects of the
changes in microfinance, and specifically, the impact of a more homogenous microfinance industry on the
most impoverished borrowers. As the microfinance industry becomes more homogenous and focused on
financial sustainability, the ability for the most impoverished to borrower is negatively affected.
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